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If Pennsylvania were to implement a severance tax on natural gas production without additional protections for landowners, they would likely see smaller royalty checks, according to an analysis by the state’s Independent Fiscal Office.

The analysis was conducted at the request of Republican state Sen. Lisa Baker, who represents parts of Northeast Pennsylvania, where post-production royalty deductions have been a hot button issue in recent years. Baker asked the IFO whether the latest severance tax proposed by Democratic Gov. Tom Wolf would add to those expenses, which are often deducted to cover the costs of gathering, processing and transmission.

“States that levy a natural gas severance tax allow those amounts to be treated like a post-production cost,” the IFO said in its analysis. “Hence, they are deducted from the base against which the contractual royalty rate is applied.”

Wolf has proposed a severance tax every year since taking office in 2015. As part of his 2018-2019 budget, Wolf wants the Republican-controlled legislature to pass a volumetric tax that would rise and fall with gas prices. The IFO, however, failed to review the specific language of the governor’s proposal, which would prevent producers from passing on the costs of a severance tax to landowners, according to the administration.

“Gov. Wolf’s severance tax proposal explicitly prohibits the deduction of any post production costs in determining the royalty fee being paid, which the IFO did not account for in this analysis,” Wolf spokesman J.J. Abbott said. “A severance tax would ensure every Pennsylvanian benefits from the resources being extracted from underneath our feet.”

Under the proposal, producers would pay 4-7 cents/Mcf based on a price range of below $3.00/Mcf to more than $6.00/Mcf. The plan would retain the state’s existing impact fee, which is levied on all unconventional wells during their first 15 years of operation, regardless of how much they produce. Abbott added that the royalty protection has been included in the governor’s previous proposals as well.

The IFO examined state income tax returns from 2012-2016 from the state’s top producing counties, including Susquehanna, Washington, Bradford, Greene, Lycoming, Wyoming, Tioga and Butler, which comprised nearly 90% of total state production. The analysis excludes royalties paid to state lands. It also could exclude some amounts paid to individuals living out-of-state. It does include signing bonus payments, and the IFO noted that 2016 data is still preliminary and could be subject to revision.

The analysis found that royalty payments were $919 million in 2012, peaked at $1.62 billion in 2014 and then declined to $639 million in 2016.

Assuming a tax rate of 4.2 cents/Mcf, the IFO estimated that the proposed severance tax would generate $210 million of tax revenue during the first fiscal year. By the third year, the IFO assumes the tax rate would increase to 5.3 cents/Mcf and generate $379 million in state tax revenue.

The analysis assumes that the average Pennsylvania royalty rate is 13.5%. If so, and without Wolf’s proposed royalty protection, then $28 million of the proposed severance tax could be passed back to landowners in the first fiscal year. By the third year, $51 million could be passed on to landowners.

“Lawmakers should heed this warning and focus instead on pro-growth policies that expand natural gas production and use -- not higher energy taxes that depress royalty earnings, increase residential energy costs and hurt the commonwealth’s economy,” Marcellus Shale Coalition President David Spigelmyer said of the analysis.

The collapse of natural gas prices in 2015 and 2016, the IFO said, led to the large reduction in estimated royalty payments. The office does expect statewide royalties to increase “appreciably” in 2017 on firming prices.

Since it was enacted in 2012, Pennsylvania has collected more than $1.2 billion in impact fees for distribution to local communities and state agencies. But steeper deficits in recent years have led to continued calls for a severance tax on natural gas production which has led to partisan fights and budget impasses.

Senior Editor | Pittsburgh, PAJamison Cocklin joined the staff of NGI in November 2013. Prior to that he worked as business and energy reporter at the Youngstown Vindicator, covering the regional economy and the Utica Shale play. He also served as a city reporter at the Bangor Daily News and did freelance work for the Associated Press. He has a bachelor's degree in journalism and political science from the University of Maine. jamison.cocklin@naturalgasintel.com

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